Fiscal Governance and State-Building

Report

Fiscal governance and state-building

Mark Miller, Bryn Welham and Abraham Akoi

September 2017 Overseas Development Institute 203 Blackfriars Road London SE1 8NJ

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Cover photo: Museum of The Asian-African Conference: flags of the 29 newly independent countries at the museum. © Gwmb2013 | Dreamstime Acknowledgements

We thank Verena Fritz, Simon Gill, Tom Hart, Philipp Krause and Hamish Nixon for comments on previous drafts of this paper. This paper was generously supported by the Swedish International Development Cooperation Agency. The views and analysis are the responsibility of the authors alone. We would also like to thank Richard Hughes who provided programming support, Julia Hanne for overseeing the production of the document, Angela Hawke and Alasdair Deas for editing and proofreading, and Garth Stewart for document design.

Fiscal governance and statebuilding 3 Contents

Acknowledgements 3

1. Introduction 6

2. The role of fiscal governance in building European states 7 2.1. Introduction 7 2.2. The threat of war and the transformation of fiscal institutions 7 2.3. Fiscal reforms as a spur to bureaucratic modernisation 8 2.4. Fiscal reforms as precursors for more representative government 8 2.5. Summary 9

3. The links between fiscal governance and state-building objectives 10 3.1. State-building and fragility 10 3.2. Fiscal governance and the capability of the state 10 3.3. Fiscal governance and state legitimacy 12 3.4. Summary 13

4. Fiscal institutions have developed differently in fragile states 15 4.1. Reliance on external revenues to finance state functions 15 4.2. The formation of nation states and ‘competing authority’ within states 17 4.3. Summary 17

5. The role of external actors in fiscal governance and state-building 19 5.1. Approaches to reform 19 5.2. The content of fiscal governance reforms 20 5.3. Mitigating the impacts of aid and natural resources revenues 21 5.4. Advancing the research agenda on fiscal governance and state-building 22 5.5. Conclusions 22

References 23

4 ODI Report List of figures

Figure 1. United Kingdom*: central government receipts and expenditure as share of gross domestic product, 1700-2015 7

Figure 2. Volatility of revenues in South Sudan (US$ millions) 11

Figure 3. Non-resource taxation is more closely associated with state accountability than revenue more generally: five-year averages, 1996 to 2014 16

Figure 4. Non-resource taxation is more closely associated with state effectiveness than revenue more generally: five-year averages, 1996 to 2014 16

Fiscal governance and statebuilding 5 1. Introduction

The interest in state-building in post-colonial development Collier, 2007; Kharas and Rogerson, 2012). Furthermore, thinking is relatively new. Historically, the need to ‘build conflict and/or political instability can be key determinants states’ has received less attention than the need to build of the significant differences in long-term growth rates effective markets to generate wealth, or build effective between low-income countries that are in other respects political institutions to deliver democracy and respect for fairly similar (Salinas et al., 2015; Fofack, 2010). individual rights. State-building is seen as critical to resolving state fragility: State-building has often been seen as a sub-field of indeed, the OECD (2007) has suggested that state-building European history (e.g. Tilly, 1990) or as part of the early is the central objective of engagement in fragile states. study of public administration (e.g. Weber, 1978). Early State-building refers to ‘the set of actions undertaken by post-colonial development thinking assumed that a well- national and/or international actors to establish, reform and functioning state was available to implement the ‘correct’ strengthen state institutions where these have seriously been economic policies (e.g. Rostow’s 1962 theories of stages of eroded or are missing’ (Fritz and Rocha-Menocal, 2007: economic growth or Lewis’ 1954 dual markets approach). 13). State-building means both building state institutions Later debates assumed that the state was inherently capable of performing certain functions and strengthening detrimental and needed to be restrained if the private the legitimacy of the state by supporting more constructive sector was to flourish (e.g. the stereotypical ‘Washington relationships between state and society (DFID, 2010). Consensus’ model of economic development). This emerging interest in state-building has focused Since the 1990s, however, there has been a stronger attention on accounts of how states were built in today’s focus on the role of the state in development. There is, for developed economies. A number of authors (Bonney, example, a wider recognition – perhaps even a general 1999; Ertman, 1997; Glete, 2002; Brewer, 1990) recount acceptance – that ‘governance matters’ for development, and the evolution of modern European states whose survival that patterns of state/society interaction will shape overall depended on military prowess. Where ‘states’ were not able development outcomes (e.g. Kaufmann et al., 1999). More to protect themselves from invasion, they ceased to exist. At recent thinking has, therefore, aimed to ‘bring the state back the centre of this narrative is the role of fiscal governance in’ to questions of development (World Bank, 1997). – the institutions, rules and norms that structure how As part of this discussion, some commentators have public money is raised and spent (Anheier, 2013) – in state tried to reconceptualise what ‘development’ means to formation. Today there is growing interest in understanding emphasise that it must include an increasingly sophisticated whether fiscal governance reforms might play a similar role bureaucratic capability alongside traditional conceptions in supporting state-building, particularly in fragile settings. of greater economic output and more inclusive political This report aims to provide practitioners with an institutions (Pritchett et al., 2010; Fukuyama, 2011). accessible guide to the existing academic and policy ‘State weakness’ – an inability of the state to deliver literature on the relationship between fiscal governance and basic public goods or undertake essential functions – is state-building. More specifically, the report: increasingly seen as a key challenge for global development (e.g. Ghani et al., 2005; Besley and Persson, 2011a). The •• provides a summary of how changes in fiscal governance problem of ‘state weakness’ is often expressed in the concept played a central role in the development of modern of a ‘failed’ or ‘fragile’ state. There are many definitions of European states what constitutes such an entity, and the term itself is not •• shows how these historical relationships underpin without controversy (Hagmann and Hoehne, 2009). contemporary arguments for supporting fiscal governance In general, fragility is defined as states that are unable – reforms as a way to build more capable and legitimate or unwilling – to protect their populations from insecurity, states to foster economic development or deliver basic public •• outlines key reasons why state-building in fragile states goods (World Bank, 2011). For some thinkers, fragile states today has followed a very different path to that taken in represent the central problem of development in the modern early modern Europe, and the effects on fiscal governance era. By many measures, widespread and enduring income •• concludes by outlining the implications for external poverty will increasingly be concentrated in such states (e.g. actors looking to support state-building.

6 ODI Report 2. The role of fiscal governance in building European states

2.1. Introduction 2.2. The threat of war and the The idea that taxation and spending shaped the transformation of fiscal institutions development of states has a long history. It was Schumpeter During the early modern period, interstate competition who first gave rise to a body of literature often referred threatened the very survival of European states. To prevent to as fiscal sociology (Moore, 2004). He believed that the the invasion and loss of territory under their control, states drivers of social, economic and political change could only needed to finance their war-making capabilities, while ever- be understood by appreciating how states had grappled more sophisticated warfare required ever-greater financing with the challenges of raising and spending public funds: (Bonney, 1999; Ertman, 1997; Glete, 2002; Brewer, 1990). ‘the fiscal history of a people is above all an essential part The threat to survival posed by interstate competition placed of its general history’ (Schumpeter, 1991: 100). significant demands on the public purse (see, for example, Much of our understanding of contemporary state- the sharp rise in receipts and expenditure in the UK during building, therefore, rests on our understanding of the ‘fiscal periods of war, as shown in Figure 1). history’ of European states during the 16th to 18th centuries The need to secure financing to wage war successfully and how this reshaped both states and societies. This chapter led to a transformation in the way European states collected provides an overview of the literature on the history of fiscal and used public monies (Tilly, 1990). Pre-modern European governance and state-building in Europe; drawing primarily states relied upon wealthy individuals to collect taxes under from Tilly (1990), Moore (2004), Brautigam (2008) and a system often referred to as ‘tax farming’. In practice, this Krause (2013).

Figure 1. United Kingdom*: central government receipts and expenditure as share of gross domestic product, 1700-2015

70% Second World War First World War 1939-1945 60% 1914-1918

50% War of American Independence 1775-1783 40% French Revolutionary and 30% Napoleonic Wars 1790s-1810s Seven-years War 20% 1756–1763

10%

1700 1710 1720 1730 1740 1750 1760 1770 1780 1790 1800 1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Central government expenditure Central government receipts

*Up until 1801, Great Britain, thereafter United Kingdom. Source: Bank of England, 2015.

Fiscal governance and statebuilding 7 meant that rulers relied upon wealthy landowners to collect 2.4. Fiscal reforms as precursors for funds, predominantly from peasant farmers, on their behalf. more representative government Under this system, revenue flows tended to be Pre-modern systems of tax farming relied primarily unpredictable and large amounts of the funds collected were upon coercive means to raise funds. These were costly to appropriated by tax collectors. The states that established administer, partly because of the resistance of taxpayers, larger and more predictable sources of revenues gained a but also because much of the money collected was considerable advantage over their competitors (Moore, 2004). appropriated by tax collectors. Levi (1989) describes how it was in the self-interest of rulers to come up with more consensual mechanisms to 2.3. Fiscal reforms as a spur to collect taxes as a way to reduce the loss of revenue. This bureaucratic modernisation is because effective revenue collection requires ‘quasi- As the cost of financing military operations rose, permanent voluntary compliance’ by taxpayers. Comparative analysis bureaucracies began to emerge that were responsible of the development of European fiscal institutions (Tilly, for the collection of ever-larger amounts of tax revenue. 1990) shows that where countries had institutions in place This required the development of a formal administrative to promote consensual tax regimes, they stood to benefit apparatus that allowed a coordinated network of civil from larger and more predictable revenues. servants to collect taxes across a state’s territory and channel The move towards more ‘consensual’ revenue collection the funds raised to the public purse (Brautigam, 2008). required that taxation became a more formalised and The structures put in place to collect public funds public endeavour. Tax became regulated by rules-based began to bear the hallmarks of modern bureaucracies that procedures that were negotiated and agreed upon in Weber characterised as the basis of ‘rational rule’ (Weber, the public domain, rather than subject to individual 1978). Systems were put in place to promote impersonal negotiations in private. processes that limited the discretion of tax collectors and This helped to address the collective action problem, increased the state’s oversight. Brewer (1990) describes the whereby any individual taxpayer is reluctant to pay taxes if case of Great Britain, where the British Excise Office was they believe that others might be paying less, or not paying one of the first permanent bureaucracies set up to promote anything at all (Levi, 1989). Moving away from private the efficiency of revenue collection. Key innovations negotiation to a more public discussion of tax obligations included: the introduction of salaried staff; the emergence had the effect of requiring and reinforcing a greater sense of organisational hierarchies; recruitment and promotion of ‘fairness’ in the relationships between taxpayers and the based on merit; and the introduction of standard operating state. procedures. Sustaining consent to pay taxes also required The modernisation of institutions to manage spending mechanisms to ensure that taxpayers (or creditors) could ran in parallel to changes in the apparatus for raising demand accountability for the use of money raised. funds. Historically, monarchs and landlords had their own The first assemblies of notables in modern Europe were private treasuries that were responsible for funding their formed to negotiate consent on tax and spending policies activities, and these tended to be highly chaotic (Webber and (Brautigam, 2008). These assemblies became places where Wildavsky, 1986). the revenues provided by nobles were exchanged for However, as the requirements of war drew in more mutually beneficial policies (Moore, 2004). resources, the processes for managing and controlling In the case of medieval Holland, for example, the spending became increasingly formal. Systems were required Habsburg rulers became increasingly accountable to the to reduce the uncontrolled leakage of funds and increase estate owners who issued debt to finance their military the ability of the state to direct resources towards ever-more operations. In return for financing, estates were given complicated military operations. The historical account the right to audit and control accounts, ensure money of the British and Prussian finance ministries provides was actually spent on the intended purposes (military one example: the ability of these institutions to establish operations) and given the right to appoint treasurers expenditure systems with ‘hierarchical, centralised oversight (Tracy, 2008). based on impersonal norms’ (Krause, 2013) ensured greater Over time these practices evolved into the accountability availability of resources to fight wars. and oversight mechanisms we recognise today. The budget As such, the evolution of fiscal institutions was the came to be a cornerstone of the system of democratic ‘entry point’ to wider bureaucratic modernisation (Kaldor, oversight of public finance in European states. Legislative 1963). Changes in the institutions that collected and spent oversight of the executive’s budget proposal provided money were at the forefront of a broader ‘administrative elected representatives with the opportunity to ensure that revolution’ in the rest of government (Brautigam, 2008). executive spending was in line with the preferences of The modernisation of fiscal institutions contributed to the citizens (Krause, 2013). development of a more capable public administration, albeit primarily for the purposes of war.

8 ODI Report 2.5. Summary This transformation of fiscal institutions led the way to a Much of the theory that underpins our understanding broader administrative revolution. of the relationships between fiscal governance and state- Over time, as financial management moved from a largely building draws from the emergence of states in Europe coercive private matter to a more consensual public one, between the 16th and 18th centuries. The financing checks and balances emerged to control the executive’s use of requirements of states grew in response to the threat of public funds, culminating in modern institutions of financial war. The states that flourished were those that shifted the oversight and accountability. Emerging from the need to administration of fiscal affairs away from personal and finance warfare, these changes to fiscal institutions were the informal systems and towards institutional bureaucracy. catalyst for the creation of more capable and legitimate states.

Fiscal governance and statebuilding 9 3. The links between fiscal governance and state- building objectives

3.1. State-building and fragility •• Output legitimacy involves building consent between In today’s development debates, state-building is commonly state and society based on what the state delivers to its viewed through the lens of fragile states. Indeed, the OECD citizens. This might, for example, include the provision (2007) has suggested that state-building is the central of security and the delivery of basic services such as objective of engagement in such countries. Naturally, this health and education. It is, therefore, closely related to the leads to questions about the relationship and interactions capability of the state to perform its functions effectively. between fragile states and state-building. One characteristic of fragile states is their chronic lack •• Input legitimacy depends on the processes through of even the most basic capacities (World Bank, 2011). which the state takes decisions. It requires that ‘political This undermines the ability of their governments to carry choices should be derived, directly or indirectly, from the out certain core functions that are expected of the state. authentic preferences of citizens’. It is, therefore, closely While the expected core functions might vary from state to linked to ideas of how states are to be held accountable state, there is consensus that, at a minimum, a state should for ruling in the interests of their citizens. provide a safe and secure environment in which to live (Haider, 2014) as well as basic services and macroeconomic The history outlined in the previous section management (see, for example, Ingram, 2010). The state’s demonstrated the central role that changes to fiscal ability to perform these core functions can be thought of as governance played in the development of capable and its ‘capability’ or ‘capacity’ (see Dressel and Brumby, 2012, legitimate states in Europe. Contemporary academic Tilley et al., 2015 and Krause et al., 2016 for more detailed and policy literature on state-building has revisited this discussions on issues of capacity and capability). literature to determine whether improved fiscal governance As well as lacking capacities, fragile states tend to lack could support such developments in fragile states. legitimacy. Fundamentally, a state is legitimate when its monopoly on the use of violence is accepted by citizens (Weber, 1966). Its legitimacy matters, therefore, ‘because 3.2. Fiscal governance and the capability it provides the basis for rule by consent rather than by of the state coercion’ (OECD, 2010a). Where state institutions are seen as legitimate, they are 3.2.1. Fiscal capacity and the performance of core better able to generate the commitment, coordination and functions cooperation necessary to carry out their functions (Nixon As noted above, bureaucratic modernisation of the et al., 2017). Without such legitimacy, there is always a mechanisms to collect taxes is seen as a key contributor risk that political conflicts will be settled by force, rather to Europe’s historical experience of increasing revenue than institutional forms of arbitration. When states are not collection to finance war. Today, reforms to increase tax seen as legitimate, they are unable to form constructive administration capacity are recommended as a way to relationships with their societies or manage change increase resources to finance development (IMF, 2017; through peaceful political processes. OECD, 2014). States derive their legitimacy from different sources, The capability of the state to perform its core functions with Scharpf (1997) distinguishing between ‘output is affected by the availability of revenue: this is often legitimacy’ and ‘input legitimacy’. referred to as the state’s fiscal capacity (see, for example, Besley and Persson, 2009). Without sufficient fiscal

10 ODI Report capacity, states are unable to pay for the soldiers, schools Two recent studies by the IMF (Gelbard et al., 2015; and roads needed to meet even the most basic expectations Deléchat et al., 2015) find positive correlations between of what a state should do. fiscal capacity and the ‘resilience’ of states (with resilience From a financing perspective, non-resource tax revenues measured via by a combination of the World Bank’s Country (those that are not derived from the extraction and sale Policy and Institutional Assessment (CIPA) index and the of natural resources) are seen as a particularly useful prevalence of conflict in the preceding period). They find source of funds because of their relative predictability associations between the measure of resilience and both tax and ‘sustainability’ compared to other revenue sources as a percentage of GDP and fiscal space (measured by the (OECD, 2014). Where countries rely on natural resources size of the deficit and the level of current spending). or overseas development assistance, the revenues available to finance the state’s core functions tend to be more 3.2.2. Spillovers on wider bureaucratic capability volatile. For example, South Sudan – the world’s youngest Not all financing is equal from a state-building perspective. country – depends heavily on oil revenues which have been The ability to collect taxes, in particular, is seen in the subject to fluctuating supply and price changes, as shown literature as a sign of wider state capability (Di John, in Figure 2. This can disrupt its ability to pay for the core 2010). It signals state capability because the collection functions of the state. of taxes requires administrative effort. Direct taxes Weaknesses in tax administration capacity are seen (e.g. income tax) are seen to be particularly relevant to as one reason why domestic revenue collection in questions of state capability. Where states can collect taxes fragile states tends to be low as a percentage of GDP. directly across their territory (rather than simply erecting For example, the OECD (2014: p. 55) states that ‘weak border posts to collects import duties), it is a sign that technical, technological and institutional capacities in the government has the power to administer, monitor and many fragile states also make it harder to levy taxes.’ enforce the payment of taxes (Besley and Persson, 2011b). Fiscal capacity also depends upon the state’s ability to Strengthening the collection and administration of tax is channel the revenues generated to their intended purpose. also seen as a way to motivate wider improvements in the Governments need infrastructure to make payments across overall capability of state bureaucracies. The OECD (2014) their territory (Boyce and O’Donnell, 2007). Where they suggests that reforms to tax and revenue administration are unable to control or limit spending, the revenues that ‘have been shown to catalyse reforms in other public are generated are liable to be wasted. Many fragile states sector institutions’, citing the work of Fjeldstad and Moore also rely on funding from donors. Having systems in place (2008). Prichard and Leonard (2010) find a positive that give donors ‘fiduciary confidence’ can also enhance correlation between improvements in tax administration fiscal capacity (Fritz and Rocha-Menocal, 2007). (as measured by indicators of tax effort) and measures of

Figure 2. Volatility of revenues in South Sudan (US$ millions)

12,000

10,000

8,000

6,000

4,000

2,000

0 2008 2009 2010 2011/2012 2012/2013 2013/2014 2014/2015

Oil revenue Non-oil revenue

Source: Ministry of Finance and Economic Planning, South Sudan, accessed at http://grss-mof.org/docs/historic-budgets-and-budget-outturns-2005-2015/ Note: Data for the first six months of 2011 are excluded. At this time the country moved the fiscal year from Jan-Dec to July-June.

Fiscal governance and statebuilding 11 government capacity five years later (as measured by the budgeted for and spent on government projects is a key International Country Risk Guide (ICRG). With caveats, input for any kind of performance monitoring system. they interpret this as offering some support to the idea that improvements in tax administrative capacity precede wider •• The ability to make salary payments on time and in full is improvements in government capability.1 also a critical foundation for a motivated civil service. A Prichard (2010) suggests a number of specific channels public expenditure tracking survey in Nigeria, for example, through which improvements in tax administration can showed a positive correlation in Kogi province between the benefit the wider capability of the state. facilities where staff were paid on time and the likelihood of essential drug availability from those facilities rather than •• They expand the reach of government services through private providers (Das Gupta et al., 2004). investments in the presence of tax administration in remote areas. In Bolivia, for example, the expansion There is some evidence that the quality of institutions that of customs administration to remote areas required manage expenditure is also associated with state capability. improvements in the telecommunications network, which Gelbard et al. (2015) find a positive association between an later became the backbone for other government agencies. index on the quality of budgetary institutions2 and (Country Policy and Institutional Assessment (CPIA) scores, which •• Information from tax authorities can be used to capture certain elements of government capability. A World inform and support other policy processes. In Chile, Bank study on public finance reforms in eight fragile states for example, the municipal government agencies, civil also found a weak association between improvements in and company registries and even private banks all use public financial management systems (as measured by Public the unique tax identification numbers managed by the Expenditure and Financial. Accountability (PEFA) indicators) revenue authority. and measures of government effectiveness (as assessed by Worldwide Governance Indicators) (Fritz et al., 2012). •• They contribute to innovation elsewhere in government through ‘demonstration effects’. 3.3. Fiscal governance and state legitimacy •• Tax collection agencies may also demand innovation from agencies who they depend upon to collect funds 3.3.1. Fiscal governance and ‘output legitimacy’ effectively (e.g. modernising processes for business and Output legitimacy involves building consent between state land registration). and society based on the outputs or public goods that the state delivers to its citizens (Scharpf, 1997), including The links between changes in expenditure administration security and health or education services. From a fiscal and broader state capability have not been explored to the governance perspective, this means that governments same extent in the literature. There are, however, certain mobilise revenues on the understanding that those funds parallels that can be drawn with above discussion on will be used to deliver things that taxpayers care about. taxation. This is often referred to in the literature as a ‘fiscal contract’ (for example, in Moore, 2004). •• Building the institutional architecture a state needs to Taxation is particularly important for legitimacy make payments throughout its territory is central to the because it requires the consent of citizens. As Di John expansion of a government’s reach. Fritz and Rocha puts it ‘taxation is a nexus that binds together state and Menocal (2007) note the central importance of a reliable citizens’ in a way that funds raised through other means and monitorable payment system to support a functional (e.g. natural resource revenues, aid or the profits made by civil service as the basis of state administration. governments for issuing currency) do not (Di John, 2010). Timmons (2005) provides some evidence for the existence •• Information produced routinely to manage public of this ‘fiscal contract’. Comparing 90 countries, he shows expenditure is used to support other functions of that the more a state taxes rich people (as a percentage of government. Expenditure information is critical for the GDP), the more the state tends to invest in the protection policy-making process, with recruitment decisions, for of property rights; and the more a state taxes poor people, example, dependent upon the payroll records used to the more the state invests in basic public services. The process salary payments. Tracking how much is being implication is that taxpayers get what they pay for.

1 Interestingly, their data point to a structural break since the mid-1990s, where the relationship no longer holds. They speculate whether this might be related to the introduction of semi-autonomous revenue authorities, which may limit capability spillovers from the tax administration to other parts of the bureaucracy. 2 Quality of budgetary institutions is measured using an index compiled by Gollwitzer (2011) that provides rankings based on certain features of an effective budget process, such as ‘top down processes’, ‘comprehensiveness’, ‘transparency’, ‘rules and controls’ and ‘credibility and sustainability’.

12 ODI Report On the expenditure side, well-functioning financial suggest that the budget is the ‘linchpin of the state’. As a management systems can be thought of as a ‘process for result, a budget process that is perceived as transparent, systematically relating the expenditure of funds to the fair and inclusive can yield a legitimising – and therefore accomplishment of planned objectives’ (Schick, 1966: 244). state-building – benefit. The use of fiscal institutions to deliver certain public goods In his analysis of state-building in Iraq, Savage (2014: X) is expected to strengthen the state’s legitimacy on the basis suggests that ‘a politically legitimate budgeting process may that it delivers what its citizens want and expect (OECD, also serve as a dispute resolution mechanism that offers a 2010a). The ability of the state to garner output legitimacy source of political and institutional stability through which is, therefore, linked closely to its fiscal capacity and the claimants for public funds can reach nonviolent agreements quality of its bureaucracy. on the division of these resources.’ Indeed, the very idea The outputs that should be delivered by states is, behind modern parliamentary budgeting is that officials who however, subject to some debate. While European states have been elected democratically represent the interests of were expected to provide protection and promote citizens when approving how public money is to be raised prosperity, today’s policy literature often assumes that and spent. states derive legitimacy not only from keeping societies In recent decades, budget transparency and participation safe and secure, but also from providing basic services and have come to be seen as pillars of more accountable states. macroeconomic stability (Ingram, 2010). The basic premise is that when they have greater access to Recent research by the Secure Livelihoods Research reliable information on the use of public monies, citizens Consortium across five fragile states shows that access are empowered to hold the executive to account in its fiscal to services alone does not seem to be linked consistently procedures. This strengthens trust in the state and confers with people’s perceptions of government (Nixon et al., greater input legitimacy (Carlitz, 2013). A systematic 2017). In fact, it is the engagement of community members review of the evidence on fiscal openness shows consistent in the provision of services that seems to consistently associations between ‘fiscal openness’ and measures of improve their perception of government. This points to the governance, but only a few studies identify causal effects (De importance of ‘input legitimacy’, as described below. Renzio and Wehner, 2015).

3.3.2. Fiscal governance and ‘input legitimacy’ Input legitimacy depends upon the processes through which 3.4. Summary the state takes decisions (Scharpf, 1997). It is, therefore, linked The discussion in this section has highlighted links between closely to ideas of how states are held accountable for ruling aspects of fiscal governance and state-building. in the interests of citizens. In terms of fiscal governance, this means that perceptions of the legitimacy of the state are •• Most immediately, states cannot exert the monopoly derived not just from what is delivered with public money, but of violence upon which their survival depends without also from how that money is mobilised, spent and accounted access to revenues (also called fiscal capacity). In for. The state is seen as more legitimate where mechanisms are contemporary development discourse, fiscal capacity is in place to raise revenues and manage spending in a way that also seen as critical for financing development needs. responds to the preferences of citizens and interest groups. Taxation is particularly important for building input •• It has been suggested that the modernisation of fiscal legitimacy because the development of effective, consensual institutions has the potential to spur wider improvements tax systems has, historically, required governments to talk in the administrative capabilities of states. to citizens about taxation (Levi, 1989; Tilly, 1990). Citizens accept and comply with taxes in exchange for outputs •• Improved fiscal governance can also support more (e.g. the provision of services), but also for greater state legitimate states. Where funds are used to deliver accountability. outputs that citizens care about and want, states can This process of tax bargaining is seen as a key entry derive ‘output legitimacy’. Systems of accountability for point for the political engagement of taxpayers (Moore, how public funds are allocated, raised and spent also 2007). Prichard (2010) cites the example of Chile, which influence a government’s input legitimacy. has been more successful in growing its revenue base than neighbouring countries. In addition to a number of •• Taxation is seen as particularly beneficial from a state- technocratic tax reforms, he points to processes dating back building perspective because it requires the state to be to the transition from dictatorship, where representatives capable of collecting taxes and to be legitimate enough from across the whole political spectrum were invited to for citizens to willingly pay their taxes. establish ‘an inclusive fiscal pact’ with ‘broad agreement on the contours of tax and expenditure policy’. It is not clear, however, that causality runs in one In terms of expenditure, the budget process is seen as a direction: does improved fiscal governance cause more key mechanism to build input legitimacy. Ghani et al. (2007) capable and legitimate states? or are there other factors

Fiscal governance and statebuilding 13 contributing to the capability and legitimacy of states, In European states, this ‘complex web of interdependent which then lead to more effective fiscal governance? Besley causality’ seems to have been mutually reinforcing. By and Persson (2011b: 5) suggest a much more complex contrast, it is rare to see robust fiscal institutions in fragile picture: ‘[h]istorical accounts demonstrate vividly that states: weak fiscal governance has tended to co-evolve with state authority, tax systems, court systems, and democracy limited bureaucratic capacities and a lack of legitimacy. coevolve in a complex web of interdependent causality. The next section explores why this is so, before the final Simplistic stories that try to paste in unidirectional section reviews the implications for external actors looking pathways are thus bound to fail.’ to support state-building efforts in today’s fragile states.

14 ODI Report 4. Fiscal institutions have developed differently in fragile states

Current arguments for supporting fiscal governance •• Limited incentive to modernise the bureaucracy. reforms as part of state-building draw heavily on the role Where states can access funds from external sources, played by fiscal institutions in the development of modern the returns to investment in the capability to generate European states. However, today’s fragile and conflict- revenues across their territory become less attractive, affected states face a very different set of circumstances and there is less incentive to spend money in a way to those found in Europe. The dominant narrative in the that responds to the needs of citizens. This, in turn, can literature on European state-building is that interstate undermine wider bureaucratic capabilities. competition provided the conditions for the shared interest of mercantile and political elites in financing a centralised These factors help to explain why, on average, states state that provided protection from external threats. that are more reliant on non-resource taxation tend to be This section explores how two key departures in the more accountable and effective (see Figures 3 and 4). external environment faced by today’s fragile states have Chaudhry (1997) provides some evidence of causal contributed to an evolution of fiscal institutions that differs linkages between a reliance on natural resources and markedly to the evolution seen in Europe. state weakness. She documents how the effects of moving away from a reliance on taxes in Saudi Arabia (towards a reliance on oil) and Yemen (towards remittances from 4.1. Reliance on external revenues to migrants working abroad) eroded not only the capacity finance state functions of the domestic tax authority, but also more broadly The first key departure from the European state-building the ability of bureaucracies to undertake independent story is the differences in the incentives to mobilise verification and information gathering on other state domestic revenues. Today’s fragile states are on the functions. periphery of a global economy, where states can generate There is also an ongoing debate on whether financial revenues externally, rather than having to look inwards for assistance from foreign governments can undermine the funds (Moore, 2004). building of accountable government. Financial assistance Moore (2004) identifies ‘political pathologies’ that stem may be in the form of aid or, in countries seen to be of from a dependence on the extraction and sale of natural strategic importance, military aid. resources to mobilise revenues. Bates (2010: 63) asserts that in the newly formed nations in the 1960s ‘public officials and technocrats, •• Autonomy from citizens, with the state and those who who might have otherwise traversed local districts seeking control natural resources having a guaranteed source of ways to strengthen the local economy found it more income that allows them to operate without reference to profitable instead to tour the capitals of the advanced citizens. industrial nations, seeking donations from abroad’. This has given rise to concerns of ‘an aid institutions •• Vulnerability to external military intervention and coups paradox’ (Moss et al., 2006): where states that mobilise a because of the strategic importance of commodities and significant proportion of their revenues from abroad are oil. less accountable to their own citizens. Legitimacy is sought internationally, rather than domestically. •• Weak financial transparency because of the greater There is some evidence that governments spend taxes oversight challenges associated with the financial ‘more wisely’ than money received in the form of grants. operations of state-owned oil companies rather than the A recent study by Gadenne (2017) uses variation in the central budget. introduction of a programme to enhance tax capacity

Fiscal governance and statebuilding 15 Figure 3. Non-resource taxation is more closely associated with state accountability than revenue more generally: five-year averages, 1996 to 2014

60 90

50 80

40 60

50 30

20 Revenue−to−GDP(%) 30 Non−resource tax−to−GDP(%)

20 10 10

0 0 −2. 5 −2. 0 −1. 5 −1. 0 −0. 5 0. 0 0. 5 1. 0 1. 5 2. 0 −2. 5 −2. 0 −1. 5 −1. 0 −0. 5 0. 0 0. 5 1. 0 1. 5 2. 0 Voice and accountability score Voice and accountability score

correlation 0.619 correlation 0.441

Source: ICTD Revenue Database, IMF Government Finance Statistics and World Governance Indicators (adapted from Long and Miller, 2017)

Figure 4. Non-resource taxation is more closely associated with state effectiveness than revenue more generally: five-year averages, 1996 to 2014

60 90

50 80

40 60

50 30

20 Revenue−to−GDP(%) 30 Non−resource tax−to−GDP(%)

20 10 10

0 0 −2. 5 −2. 0 −1. 5 −1. 0 −0. 5 0. 0 0. 5 1. 0 1. 5 2. 0 −2. 5 −2. 0 −1. 5 −1. 0 −0. 5 0. 0 0. 5 1. 0 1. 5 2. 0 Government effectiveness score Government effectiveness score

correlation 0.602 correlation 0.392

Source: ICTD Revenue Database, IMF Government Finance Statistics and World Governance Indicators (adapted from Long and Miller, 2017)

16 ODI Report in Brazilian municipalities to compare the way in which predecessors: namely, how ‘to project authority over resources from grants and locally raised tax revenues inhospitable territories that contain relatively low densities are used. She shows that locally raised taxes are used of people’ (Herbst, 2014: 11). In such circumstances, the to improve both the quantity and quality of municipal relative costs of extending the reach of a formal state education infrastructure, while increases in grants have across a territory are that much higher. no impact. Eubank (2012) argues more speculatively that To overcome this problem, colonial authorities relied the dependence of the Government of Somaliland on upon the authority of alternative, lower-level political domestic revenues (as a result of ineligibility for overseas institutions of the kind that were once pushed aside development assistance) has fostered more responsive and in Europe. Power was often delegated to an array of inclusive forms of government than are seen in many other ‘devolved authorities’, such as local chiefdoms. low-income countries that are aid-dependent. Although the colonial governments are long gone, Concerns have also been raised about whether the these patterns of overlapping authority have persisted. provision of aid might undermine incentives to build the ‘Informal governance institutions’ such as local chiefs, capacity to mobilise revenues domestically. Aid could traditional leaders, religious groups and neighbourhood discourage governments from levying taxes on citizens as a groups tend to exercise an authority over defined areas politically less costly source of revenue. However, aid can that often overlaps with the reach of the formal state also promote increased revenue collection: either directly (Khan Mohmand, 2016). As a result, the greater threat to through support for tax policy and administration reforms, contemporary fragile and conflict-affected states comes or indirectly through promoting growth (Morrissey, 2015). from contested authority within states; rather than from The most recent empirical papers on this topic point to a outside. modest but positive relationship between aid and domestic This pattern of multiple authorities has affected the revenue collection (Clist, 2014). development of fiscal institutions in fragile states.

•• The formal state does not always have a monopoly over 4.2. The formation of nation states and the collection of taxes. Using household data from 11 ‘competing authority’ within states countries, Olken and Singhal (2011) demonstrate that The second key departure from the history of European community-based informal tax systems are widely used state-building is the way in which today’s nation states in rural areas to finance public goods, such as schools have been formed and the implications for the authority or roads, where there is an absence of formal state of the state. The European states seen in a contemporary provision. A study on ‘ungoverned spaces’ in Nepal map can be thought of as the survivors of a long period found just 10% of respondents paying formal taxation, of interstate competition. The ‘enormous majority’ of while 45% paid taxes to non-governmental actors – Europeans states failed as a result of wars (Tilly, 1990) particularly religious organisations (Mallett, 2016). and were absorbed by the victors. The national borders of European states, therefore, evolved through successive •• The reach of formal tax and expenditure institutions wars as the victorious states expanded the territory under across the state is often limited. Herbst (2014: 126) their control. As part of this process, states emerged as suggests that in many African countries ‘the spatial dominant political authorities, having defeated alternative, structure of revenues, and thus of the state itself, is very lower-level political institutions, such as fiefdoms or areas much as during the colonial period: concentrated in the controlled by large landowners (Khan Mohmand, 2016). capital and the few other areas of the country where it In other regions, the formation of states in the wave easy to tax.’ of decolonisation that began in the late 1950s followed a very different path. The boundaries of new states mirrored •• Where authority is contested, taxation may also be used the arbitrary lines put in place during colonialisation. to erect divisions rather than to bind state and citizens The British Prime Minister Lord Salisbury summarised together in a common fiscal contract. Moore (2015) the 1884-85 Scramble for Africa in the following terms: suggests that the emergence of a fiscal contract is not ‘we have been engaged in drawing lines upon maps where a given. Indeed, tax can be used to exacerbate political no white man’s feet have ever trod; we have been giving divisions among taxpayers perceived as a threat to away mountains and rivers and lakes to each other, only political elites. hindered by the small impediment that we never knew exactly where the mountains and rivers and lakes were’ (Michalopoulos and Papaioannou, 2017). 4.3. Summary The direct administrative reach of these new nation Contemporary fragile states have evolved under a very states rarely spanned the territories of the nation shown on different set of circumstances to those found in early a map. Post-colonial governments found themselves facing modern Europe. Today’s states are more likely to face the the very same problem in building states as their colonial threat of contested authority within them, rather than

Fiscal governance and statebuilding 17 threats from external sources. The availability of revenues states are very different to the impersonal bureaucracies from natural resources and aid also mean that control of developed in Europe. these funding sources delivers major returns. Unlike the What does this mean for external actors looking to accounts of Europe, governing authorities and economic support state-building processes in fragile states? How elites in fragile states do not have the same aligned might their actions affect fiscal governance and state- incentives to invest in an inclusive fiscal contract that building? Can they hope to support state-building through secures a stable source of revenues for shared stability and fiscal governance reforms? These questions are explored in prosperity. As a result, fiscal institutions in today’s fragile the final section.

18 ODI Report 5. The role of external actors in fiscal governance and state-building

This final section considers how international organisations Afghanistan, Liberia and Sierra Leone have, at some point, might influence fiscal governance as part of wider state- tried to introduce medium-term fiscal frameworks and building efforts. It examines: programme-based budgeting. Where reforms are overambitious, there is a risk that they •• approaches to fiscal governance reform may hinder, rather than support, the development of capable •• the contents of fiscal governance reform and legitimate states. Pritchett et al. (2010) suggest that •• the management of aid and natural resource revenues donors have often been guilty of supporting reforms that •• the research agenda on fiscal governance and state- contribute to ‘premature load-bearing’. Where targets are, in building. reality, beyond reach, states may imitate the organisational forms of advanced countries (how systems look) without necessarily changing the underlying functions (how systems 5.1. Approaches to reform work). This is because the look of an organisation is easier One common view in the policy literature is that although to change over a short period of time than its functions. fiscal governance reform is hard, it is both possible and Indeed, a study of PFM reform in 31 countries in indeed easier than influencing other aspects of governance. sub-Saharan Africa shows that countries have made much Gelbard et al. (2014: 47) suggest that ‘[w]hereas broad- greater progress on measures of institutional form than based institutions, as defined by Acemoglu, Johnson and on function (Andrews, 2010). This ‘isomorphic mimicry’ Diamond (2004), are deeply rooted in history and highly runs the risk of overburdening systems with unnecessary persistent, fiscal institutions can be bolstered and policies complexity, given the limited available capabilities. It also implemented over a relatively shorter period.’ focuses fiscal reform on garnering legitimacy from external They suggest that the content of fiscal reform should, in actors, rather than domestic constituents. broad terms, be consistent across countries, but that external In the wider literature on institutional development, supporters should manage their expectations on the scale critical voices have questioned the ability of external actors and speed of results when supporting fiscal governance to design and orchestrate a sequenced reform path. Here, reform in fragile states. Calculations by Pritchett and de the debate on donor engagement in improving capability Weijer (2010) for the 2011 World Development Report in fragile states has moved away from ‘best practice’ suggest that even under the most optimistic scenarios, where transfer towards frameworks that support: ‘good enough institutions improve in line with the average pace of the best governance’ (Grindle, 2007); ‘going with the grain’ of local 20 performing countries, it takes 20 to 30 years to reach politics (Booth, 2011); searching for small-scale practical thresholds of average state capability.3 answers to immediate problems (Easterly, 2006); using In practice, there is still a discrepancy between the iterative reform approaches that build in experimentation stated need for modest ambition and the actual reforms and tolerance for failure (Andrews 2013); and ‘starting with supported by external actors. Case studies of public financial problems and opportunities, not comprehensive solutions’ management (PFM) reform in fragile states (Fritz et al., (Williamson, 2015). 2012) suggest that while progress is possible across different dimensions of PFM, the greatest progress was made on the 5.1.1. Recommendations on approaching reform indicators of budget execution. External actors also tend to •• Ultimately, sustainable fiscal governance reform means introduce quite advanced technical reforms. For example, institutional development, and the new thinking on this

3 If bureaucratic quality were to improve at the same average pace as other non-fragile countries, then the time taken for fragile states to reach a threshold measure of state capability would be 116 years according to ICRG indicators and 2,646 years using World Bank measures of government effectiveness.

Fiscal governance and statebuilding 19 agenda should be taken on board. For improvements in Earmarking requires that revenues earned from fiscal governance to be sustainable, they need to coalesce one source be solely dedicated to specific expenditures into functioning institutions. Recent thinking on (Welham et al., 2015). From a state-building perspective, institutional reform in low-income countries provides a it is justified as it can support ‘tax bargaining’ between number of clear lessons about how external actors can state and citizens, although it limits flexibility of finance best support genuine institutional development. These ministries to reallocate resources. The idea is that states emphasise long-term support to a country-led agenda can build consensus over changes to tax policy by linking of incremental and iterative change. Each context will revenues to particular expenditure programmes. Prichard be different, but this learning should inform the manner cites the example of an increase in value added tax in in which external support is delivered to support fiscal Ghana (from 10% to 12.5%), which faced strong public governance reform. opposition. In addition to an impressive public relations campaign that helped to generate greater acceptance for •• There is a need for serious thought about the time the reform, the increased collection was earmarked for a frames for what can, realistically, be achieved, given new Education Trust Fund. that the processes by which capable European states Joshi and Ayee (2008) have explored approaches of developed took several centuries. The key fiscal associational taxation as a way to bring the informal governance reforms that contributed to capability sector into the tax net. Citing examples from Ghana, Peru in particular states took many years to fully and Senegal, they argue that prospects for sustainable institutionalise, and major reforms may have happened taxation are improved by negotiation between the state only once in every few decades. However, many reforms and associations that represent parts of the informal sector. to PFM systems in today’s fragile states aim for a level In each of these countries, the government has brought of sophistication far beyond those found in European parts of the informal sector into the tax net by delegating states at a comparable stage of economic development. responsibility for the collection of certain fees to trade External actors should, therefore, review their associations. Joshi and Ayee suggest that the effectiveness expectations for the magnitude and speed of results of such measures depends on the revenue imperative facing when supporting state-building processes through fiscal a government (i.e. is central or local government facing a governance. fiscal crisis that requires potentially unpopular reform) and the ability of trade associations to bargain collectively with a government. 5.2. The content of fiscal governance Kiser and Sacks (2009) argue that centralised, reforms bureaucratic tax administrations may be a poor fit for An emerging body of literature, particularly on taxation the economies of many states in sub-Saharan Africa and state-building, questions whether the content of because limited fiscal capacity and poor transportation standard tax-reform recommendations are appropriate and communication limit the ability of states to monitor for the achievement of state-building objectives (see, for and sanction tax collectors. They contend that under example, Brautigam et al. 2008; Prichard, 2010, 2015). certain conditions, the systems of tax collection used in Doubts are raised about whether an approach to taxation early modern Europe may be more suitable. This might built primarily around ‘economistic’ notions of efficiency include options to decentralise or delegate responsibilities about tax collection will capture the potential benefits to for tax collection; or contracting out certain tax collection building capable and legitimate states outlined earlier in responsibilities. this report. Less has been written on the expenditure side, but Fjeldstad and Moore (2008), for example, review similar concerns for the appropriateness of standard public systems of taxation in Tanzania. They suggest that a focus expenditure reforms could be valid. There is, for example, on strengthening the large taxpayers office has resulted in a tendency to push for the centralised management of all just 286 firms paying 70% of domestic taxes, while many government bank accounts on the grounds of efficient cash members of the professional classes pay no tax at all. While management. There could, however, be situations where such an approach may be ‘efficient’, the authors worry that allowing service providers to retain and manage their a focus on this narrow group overlooks opportunities to own revenues might have benefits from an accountability foster a social contract between state and citizens. perspective. Prichard (2010) summarises possible alternative Similarly, many PFMreform programmes have promoted approaches to tax reform that maximise opportunities a centralised finance ministry to manage the performance for tax bargaining, including recommendations that of line ministries. In Rwanda, however, systems of run counter to ‘standard public finance theory’. For performance management have been built around the example, he champions earmarking of revenues as a way moral rewards and sanctions of the imihigo system, to strengthen the links between revenues raised and the whereby local officials pledge publicly to achieve certain ‘outputs’ delivered by the state in return. objectives (Chambers and Booth, 2012).

20 ODI Report Given weaknesses in the fiscal capacity and capability 5.3. Mitigating the impacts of aid and of prevailing fiscal institutions, there may also be natural resources revenues situations where ‘privatising’ responsibility for expenditure This report has highlighted that the capacity to collect taxes management could work. During a recent roads project has a much greater return from a state-building perspective in Liberia, the World Bank contracted out responsibility than the collection of revenues from other sources. Concerns for both construction and maintenance of road building have also been expressed that a reliance on external resource to address the persistent pathology of under-budgeting for flows can undermine the development of responsive, domestic maintenance in a weak institutional environment (World political institutions. In the short term, however, there may be Bank, 2015). little that can be done to diversify the revenue base. External actors may, however, be able to influence the Recommendations on the content of reform way in which resources from other sources are managed. •• Empirical evidence to support possible alternatives A number of initiatives have emerged in the extractive to standard reforms is based largely on individual industries sector to bolster the institutional mechanisms case studies. This raises obvious questions about the that hold governments to account for the extraction and external validity of the findings. None of the examples use of natural resource revenues (Meijía Acosta, 2013). provide a blueprint for a distinct approach for reform Examples include Publish What You Pay and the Extractive that supports state-building. What they do highlight, Industries Transparency Initiative, which advocates a global however, is that there could be more room for standard for transparency among business and governments. experimentation than is often acknowledged. Piloting The CONNEX initiative agreed by the G7 aims to help alternative approaches and measuring their effectiveness developing country governments secure better deals from could reap dividends. It would also be useful to state contracts with extractive companies by providing support more explicitly how planned reforms are likely to for negotiations. interact with state-building goals. There are also debates on how aid can best be provided to mitigate potentially negative impacts on the •• A standard package of fiscal reforms may not always be accountability of states to their citizens. In a background appropriate. A number of examples of country reform paper to the 2017 World Development Report, Devarajan challenge some of the received wisdom on fiscal reform: and Khemani (2016) suggest that external actors should associational taxation; earmarking revenues to gain provide not only lump-sum transfers to governments (i.e. popular support for tax policy changes; contracting budget support), but also research products and associated out certain fiscal functions; and incorporating informal knowledge that build the capacity of citizens ‘to select and governance institutions (e.g. imihigo) into processes sanction leaders who have the political will and legitimacy of fiscal governance. There is a need, however, for to deliver the public goods needed for development.’ more rigorous evaluation of the effectiveness of these It has also been suggested that where aid uses country interventions and the conditions under which they are systems for financial management and procurement, it can likely to succeed. reduce the risks of undermining the long-term development of administrative capacities (Hart et al., 2015). Setting up •• Promoting the reform of fiscal governance means separate systems to manage donor funds is thought to divert thinking about the interactions between fiscal scarce institutional capacity away from strengthening the institutions and other actors in government. The management of governments’ own systems. It also sends a literature identifies how improvements in fiscal clear and negative message to domestic taxpayers about the institutions have spurred wider improvement in quality of government financial systems. bureaucratic development, but also how this may be Creating parallel systems of higher capability can less apparent in recent years. While ‘core’ institutions stop any positive spillovers reaching other parts of the of fiscal governance (e.g. the ministry of finance; bureaucracy (OECD, 2010b). There is also a risk that accountant general; tax collection agencies; audit a ‘dual public sector’ emerges that is ‘run parallel to, institutions) are the natural candidates for fiscal and often in competition with, national state structures’ governance reform support, other agencies with (OECD, 2010b: 69). The use of existing country systems financial management responsibility (such as major can help to mitigate these risks. There is, however, a tension line ministries, or agencies responsible for the public here: those countries in greatest need of support to improve sector payroll) also have key roles in PFM, particularly fiscal governance are also those where the fiduciary risks on expenditure. External actors should consider how tend to be greatest. and when programmes should reach beyond the core institutions of fiscal governance, and how targeted Recommendations on mitigating risks: improvements in core fiscal institutions could have •• Donor country governments can use regulation to benefits in other parts of government. influence behaviours of the extractive companies domiciled in their jurisdiction. The Natural Resource

Fiscal governance and statebuilding 21 Charter (Natural Resourec Governance Institute, 2014) institutions to other state actors. Within government, recommends that governments promote and enforce this can include understanding how financial operating public disclosure requirements in the extractive industry procedures have an impact (formally and informally) on and ensure that extractive industry projects comply with other administrative behaviours; the role, management social and environmental standards. and impact of cadres of financial management staff working outside the finance ministry; the impact of •• Hart et al. (2015) propose a number of concrete disseminating financial information outside the finance recommendations that donors can consider when ministry; and the motivations faced by financial deciding whether to use country systems when providing management, in particular. aid, including: ‘(i) understanding the country context and political economy, (ii) understanding objectives of overall •• Considering the role of non-state actors more seriously. programme and the time-frame of expected results (e.g. It would be useful to look in more detail at how different long-term state building or rapid basic services delivery), groups of taxpayers (private individuals; wealthy elites; (iii) identification of key trade-offs, including the risks small businesses; transnational businesses; informal sector of not engaging with country systems and (iv) taking workers, etc.) engage with the issue of taxation and state decisions on the level of acceptable risk tolerance to legitimacy. The research agenda could look at historical inform the degree of use of country systems.’ examples of how competing political authorities have been incorporated into systems of fiscal governance as part of peace processes. It could also consider how 5.4. Advancing the research agenda on civil society groups of different kinds have supported fiscal governance and state-building or worked against changing perceptions of the state’s More needs to be done to unpick the different elements legitimacy in the context of fiscal governance reform. through which fiscal institutions affect state capability and legitimacy. Indeed, the literature on PFM and state-building •• Increasing the financial resources dedicated to impact can be criticised for concluding that because it involves a evaluation in fiscal governance reform. There is a dearth ‘complex web of interdependent causality’ it means that of impact evaluations that look at the effectiveness of ‘all good things go together’. Much of the empirical work interventions to strengthen fiscal governance, using both looks at broad associations between fiscal institutions and conventional and non-conventional approaches. Much of measures of government effectiveness, but does not tease out the evidence for fiscal reform comes from cross-country the mechanisms through which change happens. analyses that in their very nature do not deal well with A future research agenda on this issue could, therefore, be issues of ‘best fit’ for reform. structured around the following changes in approach.

•• Considering longer time periods in research and 5.5. Conclusions evaluation work. Many evaluations of the impact of The literature is clear: there is a ‘complex web of donor-supported change in fiscal governance are linked interdependent causality’ surrounding relationships across to a donor programming cycle of three to five years. fiscal governance, overall institutional development and However, the tax and state-building literature points to state-building. It may, therefore, by impossible to pinpoint change that occurs over a far longer period. Shifting to one single, linear relationship or approach based on the longer-term evaluation of multiple external interventions experience of single interventions. Even in the absence would improve understanding of sustainable change. of strong causal evidence of the positive effect of fiscal governance on state-building or service delivery, the simple •• Looking seriously at examples where improved fiscal fact remains that there is no evidence, or any persuasive governance has not made a positive contribution to state- theory, that suggests the opposite. In other words, we cannot building. A future research agenda should be bold enough conceive of a state-building model and broader development to research cases where seemingly sustainable changes agenda that does not involve strong fiscal institutions. There in fiscal governance have not led to any appreciable is not a single prosperous and stable society today that did improvement in state capability and legitimacy in fragile not, at some point, develop capable fiscal institutions. contexts. These ‘negative results’ will provide useful Many questions about fiscal governance and state- material that can provide greater depth to the hypotheses building remain unanswered. These questions are not easy, set out in this report. but then neither is the process of state-building. Given the importance of this process to supporting development •• Looking beyond the usual core fiscal governance in fragile contexts, and the ubiquity of fiscal governance institutions. Identifying where and under what institutions across all states, a better understanding of the circumstances change occurs means looking at how role of the fiscal governance in supporting capable and reforms filter out from finance ministries and associated legitimate states seems essential.

22 ODI Report References

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